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SUMMARY
Parkev Tatevosian, CFA, presents a detailed discounted cash flow analysis of Adobe, concluding that the stock appears undervalued compared to its current market price. He discusses the assumptions, risks, and rationale behind his valuation, emphasizing the importance of risk-adjusted returns for investors.
MAIN POINTS
- Introduction of Adobe's current stock price near its 52-week low and the plan to analyze its valuation using a discounted cash flow model.
- Explanation of the free cash flow forecasts for Adobe through 2034 and the calculation of terminal value from 2035 onward.
- Details on the discount rate, including the weighted average cost of capital, cost of debt, and cost of equity, as well as the capital structure assumptions.
- Calculation of Adobe's intrinsic value per share at $360, significantly higher than the current market price of $244.
- Discussion of risks such as competition and artificial intelligence, and how these are incorporated into the valuation via the discount rate.
- Personal disclosure of owning Adobe stock, acknowledgment of potential downside risks, and the importance of being compensated for risk in investing.
DETAILED ANALYSIS
Adobe's stock is currently trading near its 52-week low, prompting questions about whether it represents an undervalued investment opportunity. A proprietary discounted cash flow (DCF) valuation was conducted, projecting Adobe's free cash flow from $10.26 billion in 2026 to $20 billion by 2034. Beyond 2034, a steady terminal growth rate is assumed, reflecting the long-term value of future cash flows.
These projections are discounted back to present value using a weighted average cost of capital (WACC) of 12.87%, which incorporates both the cost of debt (5.75% after tax) and the cost of equity (13.66%), calculated using the capital asset pricing model with a beta of 1.51, a risk-free rate of 4.6%, and a market risk premium of 6%. The capital structure assumption is set at 10% debt and 90% equity, slightly more aggressive than Adobe's current leverage, to optimize the WACC for shareholder value.
The resulting intrinsic value per share is calculated at $360, which is substantially higher than Adobe's current market price of $244, suggesting that the stock is undervalued. However, the analysis does not ignore the risks, particularly those posed by artificial intelligence and potential loss of market share to competitors. These uncertainties are addressed through the discount rate, which reduces the present value of future cash flows to account for both the time value of money and risk.
For example, an estimated $14.5 billion in free cash flow for 2029 is discounted to a present value of $8.93 billion, reflecting a significant risk adjustment. This approach ensures that the valuation remains realistic in the face of future uncertainties.
Despite the risks, Adobe is rated as one of the top 15 stocks to buy, and the analyst personally holds it in his portfolio. The investment thesis is built on the principle that risk is inherent in investing, but investors should seek adequate compensation for the risks they take. The analysis emphasizes the importance of understanding and quantifying risk, rather than avoiding it, and making investment decisions based on a clear assessment of potential returns relative to those risks.
LINKS
- Special offer for The Motley Fool Stock Advisor.
- Link to Parkev Tatevosian's book on stock evaluation.
- Discounted access to Fiscal.ai for investment research.
- Webull sign-up page with bonus shares offer.
- Subscription link for Parkev Tatevosian's Substack newsletter.
- YouTube channel membership for exclusive perks and spreadsheets.